In November 2004, some of the leading transition managers and Mercer proposed establishing a code of best practice for transition management. The ultimate aim was to provide pension funds with a set of guidelines that informed them of the key issues when selecting and assessing the performance of their transition managers.
Last October, virtually all the major transition managers operating in the UK signed up to a document called the T-Charter, the transition managers’ code of best practice.
Although the T-Charter has already come in for criticism, notably by three of its signatories, it represents a major achievement in terms of reaching a consensus about the key issues of transition management and how they should be communicated to clients.
So why was a T-Charter charter needed? The simplest answer is complexity. Transition management is a relatively complex area, and one of the few areas where pension funds have to deal with a plethora of providers from very different types of businesses.
In a typical fund management mandate, there is a clear sense of who the counterparties are, what regulatory environment they work in and which code of business practice they operate under. With transition management, however, a pension fund can be talking to a fund manager, a custodian, an investment bank or a combination of all three.
The fact that the providers of transition management come from a number of different backgrounds with different compliance obligations, regulatory frameworks and business practices means that there is a need for a common set of standards and a consistent framework for assessing these various types of providers.
Another important consideration is the fact that a pension fund is likely to appoint a transition manager only once every three years or so, and so what they remember from the last time may no longer be relevant the next time. As a result, most pension funds come to transition management relatively fresh, and with limited legacy knowledge.
My own view, and one of the reasons why I became chairman of the T-Charter initiative, is that the performance of the transition managers has not always been as good as the marketing suggests. So laying down some common standards and bringing more transparency to transition management should be a good thing.
With this in mind the T-Charter provides the necessary guidance on the key issues which are common to every transition management provider such as disclosure, confidentiality and reporting.
This approach is clearly working as a number of pension funds are using the T-Charter when drawing up their requests for proposals (RFPs), and in some cases are requesting that the transition manager be compliant with all the aspects of the T-Charter, even requiring it to be embedded in their agreement.
The T-Charter is intentionally not part of any regulatory framework. We quickly came to the view that it was neither appropriate nor feasible to generate rules that would then have to be policed by a regulator.
In the first place, we are not compliance officers, lawyers or regulators. In the second place, we had to face the fact that the regulatory environment was in the process of change, in particular with the move to MiFID. So regulation was something of a moving target.
One of the aims of the T-Charter has been to help create the conditions for a level playing field in an area of financial services which, historically, has been far from level. Yet levelling the playing field does not mean restricting competition between providers. The issues that are addressed in the T-Charter are those common to every provider.
The T-Charter does not favour one business model above another. What it aims to do is help pension fund trustees take an informed decision as to which business model and which provider is right for them, and right for a particular transition.
Where competitive issues may arise will be in how pension funds choose to use the T-Charter. A pension fund may say that it requires a transition manager to be compliant with all the aspects of the T-Charter, and may require it to be embedded in their agreement.
The extent to which a pension fund wants its transition manager to adopt the T-Charter is a matter for each fund to decide. That is exactly as it should be. The level of compliance should be a matter of negotiation between the client and the provider, rather than being mandated externally.
In fact, some providers are going one step further and competing on compliance with T-Charter. They may see it as a positive statement and a competitive advantage to be fully compliant and to have the charter embedded in their transition management agreements.
There has been some criticism that the T-Charter does not go far enough on issues like remuneration and enforcement. But we felt that narrowing options by making the T-Charter more prescriptive could have acted as a restriction of trade. It is not the purpose of the T-Charter to restrict client choices.
The main bone of contention in the years of drafting has been the issue of ‘pre-hedging’, the practice whereby investment banks, trading off their own inventory of securities, can pre-hedge the trades by buying or selling securities ahead of the transition.
The question was whether the T-Charter should outlaw this practice altogether. There were straightforward legal reasons why it should not. The UK Financial Services Authority regulations do not prohibit the use of pre-hedging by investment banks. Therefore, if the T-Charter had outlawed pre-hedging it would have meant that the charter was, in effect, superseding the rule book.
Given the positions of the regulator and the investment banks, insisting on a ban on pre-hedging would effect have tilted the playing field in favour of one set of players - those transition managers that are unable to pre-hedge.
Also, it was not by any means clear that pension funds wanted the T-Charter to prohibit pre-hedging. One interesting, if unexpected aspect, to the debate was that we had representations from a small number of pension funds who said that they would not favour a blanket ban on pre-hedging since they have benefited by allowing the investment bank to pre-hedge when transitioning their assets. It is therefore important not to prohibit something that funds believe to be of value.
All parties had concerns, and all parties have had to compromise in order to get the T-Charter launched. But we now believe that the position we have arrived at is one which meets the needs of a wide range pension funds.
The acid test of the success of the T-Charter is how it is being used currently. The anecdotal evidence is that most of the RFPs, which go out from public sector funds now are either explicitly or implicitly structured around the charter.
So not only has the T-Charter been successful in terms of the number of signatories it has attracted but also in the sense that it is helping shape pension fund RFPs. The charter is really making a difference in raising the quality of the questions posed in the RFPs.
In conclusion, it is important to state that the single most important objective of the T-Charter is to help pension funds and their boards to ask the right questions. All the indications are that this is exactly what we have done.
Rick di Mascio, chief executive of Inalytics and chair of T-Charter
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